1. This is a totally random, largely inconsequential discrepancy that I just happened to notice in Dick Fuld's testimony to the FCIC. But since this is, after all, my blog, I'm going to point it out anyway. After telling of a failed attempt to call Tim Geithner on Saturday, September 13th, Fuld told the FCIC (per Dealbook):

“From that weekend to this day I have not had a conversation with Chairman Geithner,” Mr. Fuld told examiners.

Oh Dick, you know they keep records of these things, right? What about your call to Geithner after the AIG bailout later that week, when you begged him to "undo" the Lehman bankruptcy (as recounted in Hank Paulson's book)? That call shows up in Geithner's call logs from the crisis, on the morning of Friday, September 19th:

Don't try to slip anything by me, Dick. I have a mind that remembers completely random and useless factoids like a steel trap.

2. As to the FCIC more generally, they obviously had several flaws. Not surprisingly, given my earlier post, I didn't find the final report to be terribly useful or reliable. I've listened to a bunch of the FCIC interviews (great for listening to on the train), and I agree with Yves Smith, who noted that "far too many of the well known individuals included in the roster were economists who were simply not close enough to what happened to provide much in the way of new perspective." What did they really expect to learn about the crisis from Arthur Laffer, or Bob Kuttner?

There were also some glaring omissions in the interviews. Honestly, how is it possible that the FCIC didn't interview Dan Jester? Jester was the point man for the government from Lehman Weekend on, and was probably one of the most important figures in the entire financial crisis. Ken Wilson, another hugely important Paulson adviser at the Treasury, was also somehow not interviewed. Inexplicable.

In general, I think the interviewers tended to waste a lot of time learning how major dealer banks work — which meant that they were often interviewing the wrong person. They also had a structured products expert who frankly didn't seem to know that much about structured products, and was easily confused by structured finance jargon. The main interviewer (at least in the interviews I've listened to), Chris Seefer, usually had a pretty decent grasp of the markets and financial instruments the FCIC was focusing on, but he was often clearly trying to fit the evidence into a pre-conceived narrative, which wasn't always accurate. Overall, though, Seefer was the most competent interviewer the FCIC had.

As far as I can tell so far, the FCIC didn't unearth very many important documents (although there's a multi-thousand-page SEC submission that looks like it contains some great raw data). So it's the interviews, rather than the underlying documents or the report itself, which will likely be the FCIC's most lasting contribution.

Steven Davidoff (a.k.a. "The Deal Professor" on Dealbook) is one of my favorite commentators, but I thought his recent piece on "systemically important" financial institutions was an unusually poor effort.

He starts the article with a rather brazen assertion:

The Dodd-Frank Act deliberately did not end the era of too-big-to-fail institutions. ... Dodd-Frank instead set up a structure that would let the behemoths live, but they would be caged with a monitoring approach. Too-big-to-fail institutions are to be named and subject to extra regulation.

Well, did Dodd-Frank end "too big to fail"? That's a very complicated question, and one which no serious commentator can answer with any degree of certainty right now. If large financial institutions can be successfully resolved under the new resolution authority, then the era of TBTF will indeed have ended, so any serious discussion of whether Dodd-Frank ended TBTF would have to include a detailed analysis of the resolution authority (something which I've started to do here and here). And, of course, whether the resolution authority will work depends critically on, among other things, the new "prompt corrective action" regime for large financial institutions (DFA § 166), which the Fed and FDIC haven't even begun to devise yet. So anyone who simply asserts that Dodd-Frank "did not end" TBTF fundamentally doesn't understand the Dodd-Frank Act. At the very least, it's absolutely untrue that Dodd-Frank deliberately didn't end TBTF.

Davidoff then goes on to discuss the consequences of being labeled a "systemically important" financial institution:

Too-big-to-fail banks may receive important competitive advantages from a lower cost of capital. Their cost to borrow money will be lower because they are perceived to receive an implicit government guarantee. They can also command greater access to regulators. And there are probably positive psychic effects of being labeled a big dog in the world financial economy. It may even secure the executives of these financial firms a coveted invitation to the yearly party at the World Economic Forum in Davos, Switzerland.

When people say that institutions labeled "systemically important" under Dodd-Frank are being labeled "too big to fail," it kills me. It's one of my pet peeves, you could say, because: (a) like I said before, it betrays a serious misunderstanding of Dodd-Frank; (b) it's most likely not true; and (c) to the limited extent that it may be true, you're only making it worse by casually claiming that these institutions are being deemed "too big to fail"!

Honestly, the idea that being labeled "systemically important" under Title I of Dodd-Frank gives an institution an "implicit government guarantee" is ridiculous. For one thing, these are the institutions that will be subject to the new resolution authority — something that will make it easier for an institution to fail. Also, where is this government guarantee supposed to come from? Not the Fed: Dodd-Frank stripped the Fed of its "Section 13(3) authority" to bail out individual institutions. Not the Treasury: it never had the statutory authority to bail out individual financial institutions. Not the FDIC: "open bank assistance" is prohibited under the new resolution authority. The only option would be for Congress to pass emergency legislation bailing out a faltering institution, which is something I think is highly unlikely, especially in the next several years, given how politically toxic "bailouts" have become. (Remember, even the much-loathed TARP wasn't a bailout of an individual institution, or a select group of large institutions; it was broadly applicable to all "financial institutions.")

And if being labeled "systemically important" really did come with an implicit government guarantee, then do you really think we'd see every single major financial institution arguing vociferously that they should not be labeled "systemically important"? I imagine Davidoff would counter that this just shows that the costs of the heightened regulation that comes with the "systemically important" label outweigh the benefits of an implicit government guarantee — but if that's the case, then Dodd-Frank is successfully discouraging financial institutions from becoming "systemically important," thus showing yet again that Dodd-Frank didn't "deliberately" fail to end TBTF.

Now, you could argue that the markets, whether they're right or not, will still perceive an implicit government guarantee for these institutions. First of all, I think that's wrong — the heightened regulatory regime that "systemically important" institutions are subject to will also reinforce that these institutions are eligible for the new resolution authority. Second, even if the markets (or the rating agencies) do perceive an implicit government guarantee for these institutions, that doesn't make them right. It may incrementally lower "systemically important" institutions' costs of funds in good times, but it doesn't obligate the government to bail these institutions out, which is what really matters in this debate.

Yves Smith disagrees with my take on Andrew Haldane's op-ed in the FT. After reading the op-ed, I wrote:

Strange op-ed by Andrew Haldane in the FT. No one is really pushing the argument that he's trying to shoot down.

The specific argument that Haldane was trying to shoot down, in his own words, was:

Regulators want big, complex banks to hold larger buffers of capital to protect the financial system. Big banks argue this is unnecessary because risk is diversified across their larger balance sheets.

Haldane was attempting to shoot down an argument about capital levels. It's one thing to argue that big, complex banks are safer because risk is diversified across their balance sheets — I've seen plenty of people pushing that argument. But it's entirely different to argue that because of this, big banks shouldn't have to hold larger capital cushions. I've still yet to see anyone seriously push this argument, and none of Yves' examples show anyone making this argument either.

It's perfectly consistent to argue that big banks are historically safer due to diversification, but that they should still hold larger capital cushions because of the greater potential harm caused by a big bank's failure. In fact, Haldane expressly acknowledges this in his op-ed: "[E]ven if there were [evidence that big banks are safer due to diversification], the case for big banks holding higher levels of loss-absorbing capital would not be weakened. That case rests not on the probability of large banks failing, but on their system-wide impact." So the fact that Dimon, Blankfein, and Bob Diamond all think that big banks are safer due to diversification provides no insight into their thinking on capital levels, which was the subject of Haldane's op-ed. (Yves tries to impute the argument about lower capital levels to Diamond by following his quote with, "Less risk implies less capital," but again, even Haldane acknowledges that this isn't necessarily true, and in any event, she's putting words in Diamond's mouth.) So there is still no evidence that any of the executives that Yves quotes think that big banks shouldn't have to hold larger capital capital cushions because of their diversification.

One reason you don't see any big US banks making this argument — and one reason I thought Haldane's op-ed was so strange — is that the point has been moot for over seven months now: Section 165 of Dodd-Frank already mandates that big banks hold larger capital cushions than other banks. That's a statutory requirement, and not subject to regulatory discretion. So while it's possible that UK banks are pushing the argument that big banks shouldn't have to hold larger capital cushions due to diversification, I've still not seen any evidence of this, and Yves supplies none.

David Dayen is upset because, he claims, Tim Geithner "thinks that there's a great 'financial deepening' about to take place where the demand for sophisticated financial innovations will jump. Therefore, the financial sector will need to grow and become the most reliable spur of the US economy. That's his feeling."

But is that actually what Geithner said? No, it's not. He did not, in fact, say that we need more financial innovation, nor did he say anything about the financial sector needing to become "the most reliable spur of the US economy." What he actually said, via Noam Scheiber's piece in TNR, was: (emphasis mine)

[Geithner] told me he subscribes to the view that the world is on the cusp of a major "financial deepening": As developing economies in the most populous countries mature, they will demand more and increasingly sophisticated financial services, the same way they demand cars for their growing middle classes and information technology for their corporations. If that's true, then we should want U.S. banks positioned to compete abroad.

Geithner was actually making a fairly uncontroversial point: as emerging economies like China, India, and Brazil grow, and their populations become wealther, their demand for financial services will increase. A rural Chinese farmer might need a savings account, but that's it. As China develops a robust middle class, they'll have pensions that need to be invested, they'll need financial advisors, and so on. As Chinese businesses grow, they'll have corporate treasurers who need to manage the company's cash, they'll need to raise money in the capital markets, and so on. And this is the situation that many of the large emerging economies find themselves in: their businesses are growing, and they're in the process of developing broad middle classes. (How broad or robust the Chinese government will allow its middle class to be is an open question, and I'm probably less optimistic than Geithner, but there's no question that its middle class is growing.)

Note that none of this requires any additional "financial innovation." All of the financial services I described are considered basic, traditional financial services in every advanced economy. That's why Geithner didn't say anything about "financial innovation." (In fact, the word "innovation" doesn't appear a single time in Scheiber's article.) What Geithner said was that emerging economies are going to demand "increasingly sophisticated financial services," which is unquestionably true. Like I said, most Chinese workers don't need anything beyond a savings account right now, but as they move into the middle class, they'll require increasingly sophisticated financial services — services in which, not surprisingly, many US financial institutions specialize. (And no, it's not all "Wall Street," however well that phrase may play with the crowd.)

All of this is completely uncontroversial. But because it was Tim Geithner who said it, I guess I shouldn't be surprised that commentators are actively misconstruing it as some sort of outrageous pro-Wall Street statement.

It’s now official: the week of September 15, 2008 was a really bad week to work in Morgan Stanley’s prime brokerage. And the next week wasn’t so hot either. Various internal documents released with the FCIC report provide a fairly detailed picture of Morgan Stanley’s liquidity position during the crisis, and it’s not pretty. Prime brokers like Morgan Stanley relied heavily on customer cash held in prime brokerage accounts (known as “free credits”) to fund themselves. So when hedge funds all pulled their cash from Morgan Stanley’s prime brokerage after Lehman failed, that had a direct effect on Morgan Stanley’s liquidity pool.

On one day alone (Wednesday, September 17th), Morgan Stanley’s prime brokerage lost $36.6 billion in free credits. That’s $36.6 billion instantly gone from the firm’s liquidity pool. To add insult to injury, that same day, prime brokerage customers also withdrew $12.3 billion of excess margin, which dealers also count toward their liquidity pool. For the week, Morgan Stanley’s prime brokerage lost an amazing $86.5 billion in liquidity. And the next week, they suffered an additional $43.3 billion of outflows, for a two-week total of $129.8 billion. That’s a hell of a fortnight!

Overall, Morgan Stanley’s liquidity pool was falling by tens of billions per day — the firm was basically imploding. Without the government bailout, it’s pretty clear that they wouldn’t have lasted another week.

****

Unfortunately, I had to pull the stats on Morgan Stanley’s liquidity pool from the internal documents posted on the FCIC’s website, because the FCIC absolutely mangled the liquidity pool numbers in the actual report. They constantly confuse the parent company’s liquidity pool with the firm’s overall liquid assets, which are two completely different measures. They include several dramatic statements like, “Morgan Stanley’s liquidity pool had dropped from $130 billion to $55 billion in one week,” which isn’t even close to right. In fact, they seem to have simply pulled that $130 billion number out of thin air, as it’s not in any of the underlying documents. At one point, they say that “By the end of September, Morgan Stanley’s liquidity pool would be $55 billion,” and then cite to an email written on September 19th. (And the email was talking about parent company liquidity anyway!) Basically, it’s clear from the report that the FCIC didn’t understand anything about liquidity management — which, given the prominent role liquidity management played in the financial crisis, is pretty sad.

About Me

I'm a finance lawyer in New York. I used to focus on derivatives and structured finance (you know, back when there was a structured finance market). I spent the majority of my career at one of the major investment banks. My background is in economics and, unfortunately, politics.

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